Good morning, everyone, and welcome to Lowe’s Companies third quarter 2014 earnings conference call. This call is being recorded. Please note, if you pressed star one to enter the question queue prior to the start of today’s call, your signal did not register. You will need to press star one again to enter the queue. Supplemental reference slides are available on Lowe’s investor relations website within the investor packet. While management will not be speaking directly to the slides, these slides are meant to facilitate your review of the company’s results and to be used as a reference document following the call. During this call, management will also be using certain non-GAAP financial measures. The supplemental reference slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures.
Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management’s expectations and opinions reflected in those statements are subject to risks, the company can give no assurance that they will prove to be correct. Those risks are described in the company’s earnings release and in its filings with the Securities and Exchange Commission. Hosting today’s conference will be Mr. Robert Niblock, Chairman, President, and Chief Executive Officer, Mr. Mike Jones, Chief Customer Officer, and Mr. Bob Hull, Chief Financial Officer. I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.
Good morning, thanks for your interest in Lowe’s. I am pleased with our strong performance in the third quarter. Comparable sales were 5.1%, driven by an increase in comp average ticket of 3.4% and an increase in comp transactions of 1.7%. We saw balanced performance this quarter across our three business areas, building and maintenance, home decor, and seasonal, as all delivered comps within a tight range. We had positive comps in all 12 product categories, with particular strength in fashion fixtures, kitchen and appliances, millwork, and outdoor power equipment. Sales across the country were balanced as well, with all three divisions, the North, South, and West, all generating comps in the mid-single digits. In fact, all 14 regions had positive comps. We saw continued strength in our pro services business, which outperformed the company average during the quarter.
I'm pleased to share that our team in Canada delivered double-digit comps in local currency for the sixth consecutive quarter. We remain focused on improving our profitability, even while investing in key capabilities to drive sales growth. For the quarter, we drove 81 basis points of operating margin expansion and earnings per share of $0.59, a 25.5% increase over last year's third quarter. Delivering on our commitment to return excess cash to shareholders, in the quarter, we repurchased $900 million of stock and paid $229 million in dividends. We're pleased with our performance in the third quarter continue to be cautiously optimistic about the home improvement landscape. Disposable personal income and revolving credit usage, which are key drivers of discretionary consumer spending, appear to be improving above the relatively weak trends experienced during most of the recovery to date.
The consumer is also benefiting from lower interest rates and falling fuel prices. Existing home sales remain on a modest uptrend, and the latest reading on the broadest measure of home price growth, FHFA, improved modestly from last quarter, suggesting home price appreciation in small to mid-size markets continues, which bodes well for consumers in Lowe's footprint. These positive trends align with recent consumer confidence readings and the results of our third quarter consumer sentiment survey, which revealed that homeowners' views around personal finances and home values continue to improve. In fact, confidence in both local and national housing markets increased to pre-recession highs this quarter. In addition to the improvement in sentiment, homeowners disclosed that now, more than any time since 2006, they are looking to invest in their homes.
While most consumers plan projects are still small ticket, we are seeing a rise in big ticket projects, which is encouraging. Continued improvement in the macroeconomic landscape, together with our strengthening execution, strategic priorities, and keen focus on productivity and flow-through, give us confidence in our business outlook for 2014. I would like to thank our more than 260,000 employees for their efforts in achieving this quarter's strong results and for their unwavering commitment to serving customers while we further transform our business model. We look forward to sharing our long-term vision for the business at our Analyst and Investor Conference on December 11th. Thanks again for your interest. With that, let me turn the call over to Mike.
Thanks, Robert. Good morning, everyone. As Robert shared with you, we had a strong quarter with positive comps across all regions and all product categories. We continue to capitalize on an improving macro backdrop through enhanced sales and operations planning process, improve our relevance with the pro, and develop customer experience design capabilities. Our outdoor power equipment category experienced the strongest growth in the quarter with double-digit comps. A milder summer helped lawns stay healthy well into the fall, and we are prepared to meet strong demand for mowers and trimmers with great national brands like Husqvarna, John Deere, and Troy-Bilt supplemented with the launch of our Kobalt line of battery-powered, handheld outdoor power equipment. In addition, concern about another cold, wet winter prompted many customers to buy snow throwers and other winter products earlier this year.
We were able to meet that early demand thanks to strong vendor partnerships and a robust distribution network. We also drove above-average comps in millwork, kitchens and appliances, and fashion fixtures. All three categories benefited from customers' increasing interest in refreshing both the exterior and interior of their homes. We encouraged them to choose Lowe's for their project needs through targeted promotions and our investment in project sales specialists. We have project sales specialists that focus on the exterior of the home available across all U.S. stores, and we are continuing to expand our interior project sales specialist program as well. Our project sales specialists are simplifying the process by guiding customers through inspiration, design, and installation. Customers have responded positively to these programs, and we are pleased with their performance.
Fashion fixtures also benefited from the strong sales of light bulbs, particularly our home center exclusive line of Osram Sylvania LED bulbs, a brand customers know and trust. As Robert mentioned, our pro business continued to perform well. In fact, our pro comps outpaced the company average for the 13th consecutive quarter. The pro continues to grow faster than the rest of the home improvement market, and we strive to provide pros with great service that makes doing business with Lowe's as quick and convenient as possible. We engage with pros through multiple channels in store, where we have dedicated specialists to answer questions and dedicated loaders to help pros get back to the job quickly.
At the pros' place of business, where our account executives help maintenance, repair, and operation customers order and replenish products regionally through our national account representatives, who assist pros who do business with Lowe's across the country and online, where we are also committed to providing convenient services to pros. In fact, our beta test of lowesforpros.com is going very well. This dedicated platform is fully transactional and will also provide pros useful functionality such as the ability to develop requisition lists and the ability to see their purchase history, as well as customized product categories. This site can also be integrated with many purchasing systems that pros use to manage their business, further streamlining their day-to-day operation and helping pros work more effectively. We've been expanding our test group and have received positive feedback on the site's flexibility and ease of use.
We expect a soft launch late in the fourth quarter. We also continue to work with vendors to add brands that pros know and trust. I'd like to provide one specific example to convey the opportunity we believe we have with the pro. In August of this year, we introduced the Henry brand of roof repair and driveway sealer products to stores in Southern California, Nevada, and Arizona. Henry is a leading and relevant brand among pros on the West Coast. We use it for both residential and commercial application. In fact, our store employees told us that many pros in these markets request the Henry brand, which they prefer for its durability and ease of application. Since adding the Henry brand, we have measured double-digit comp sales of roof repair and driveway sealer products in the markets where this relevant brand was added to our assortment.
As we improve our service and product offering for the pros, it will become increasingly important for us to reconnect with pros who have not recently purchased from Lowe's and show them what's changed in our stores and online. One way we do this is through pro-focused events. For instance, September was Pro Appreciation Month in all of our U.S. stores. During the event, we offered vendor demonstrations, special values on core pro products throughout the store, and introductory credit offers. Pro Appreciation events help us strengthen partnerships by generating new business. We'll continue to use events like these, as well as targeted marketing, to drive awareness as we make further progress in addressing product and service opportunities for the pro.
As we have shared with you previously, our enhanced sales and operations planning process has enabled us to improve seasonal planning, including the cadence of inventory allocation, staffing, associate training, and marketing. This quarter, this process helped us stay connected and address customer needs for the fall, such as planning, home winterization, and exterior maintenance. We are now transitioning to a holiday focus as customers refresh their homes for holiday guests, decorate, and organize their homes after the holiday. In fact, we have repurposed the space used for the outdoor living experience to create a holiday decor experience like no other in home improvement. One which inspires customers to decorate, raise their awareness of the breadth of our holiday decor and our gift offerings, and provides project solutions relevant to the holiday micro-seasons. It starts even before the customers reach our stores.
With inspiration through our marketing and online resources, including lowes.com, creative ideas, Vine videos, and Pinterest boards. When customers arrive at our store parking lot, inflatables and live Christmas trees set the holiday mood. As they enter the store, they are met with our full holiday story. This space, initially created for our outdoor living experience, which delivered strong results and is made possible by a larger store format, provides an inspirational holiday showroom where customers can see everything from poinsettias and artificial trees to indoor and outdoor decorations and gifts. Our featured display sets the stage, inspiring customers to start dressing up their homes by showcasing coordinated trend-right holiday decorating solutions. In all cases, whether the featured display or the artificial trees, the vignettes are clearly tagged to help customers coordinate style and easily find nearby take-with inventory.
We have also consolidated our gift wrap stackouts as well as our electric stackouts to make it easier for customers to identify all the products they would need to wrap gifts and hang lights. There is more, but you get the point. It is bold, and it is rooted in research which indicates that customers want help coordinating holiday themes. We are also excited about the exclusive innovations we continue to bring to market, many of which will make great holiday gifts. These include the Pilot brand InstaBoost Jump Starter, powerful enough to jump-start cars, SUVs, and pickup trucks, yet small enough to fit in your glove compartment even with the attached jumper cables. The new Troy-Bilt Vortex 3-stage snowblower with its top rating from a leading consumer magazine, and our new Kohler Purefresh line of toilet and toilet seats, which neutralizes odors by providing a nightlight, slow-close lid, and other features.
In addition to our efforts to drive top-line growth, we are focused on driving productivity and profitability. During the third quarter, our stores did an effective job of managing payroll hours as comp sales accelerated, resulting in roughly 50 basis points of payroll expense leverage. Additionally, last year, as part of our value improvement initiative, we have reinvested in inventory to provide greater depth of high-velocity items and more job lot quantities for Pros. We have held inventory per store roughly constant in the third quarter, even while increasing comp sales. We are pleased with the progress we are making this year on sales, productivity, and operating profitability, and we continue to look for ways to improve even further. Thank you for your interest in Lowe's, and now I will turn the call over to Bob.
Thanks, Mike. Good morning, everyone. Sales for the third quarter were $13.7 billion, an increase of 5.6%, driven primarily by comp sales. Total average ticket increased 2.9% to $65.97. Total customer transactions increased 2.6%. We've anniversaried the Orchard acquisition, so these stores are now considered comp. For the quarter, comp sales were 5.1%. The monthly comps were 3.5% in August, 5.2% in September, and 6.6% in October. When compared to last year, the monthly two-year stack was relatively consistent across the quarter. Please refer to page seven in the supplemental slides for further details. For the quarter, comp average ticket increased 3.4%. Comp transactions increased 1.7%. Year-to-date, sales of $43.7 billion were up 4.6% versus the first three quarters of 2013, driven by a 3.5% increase in comp sales, the addition of Orchard, and new stores.
Gross margin for the quarter was 34.49% of sales, which decreased nine basis points from Q3 last year. The decrease was driven primarily by targeted promotions and the mix of products sold. These items were mostly offset by continued benefits from value improvement and better sell-through of seasonal goods as a result of our customer experience design efforts. Year-to-date gross margin was 34.82% of sales, an increase of 25 basis points over last year. SG&A for Q3 was 23.8% of sales, which leveraged 76 basis points. Store payroll leveraged 48 basis points as we continue to optimize hours against customer traffic. Bonus expense leveraged 24 basis points due to lower expected attainment levels relative to last year. Reset expenses leveraged 13 basis points, the result of elevated expenses in Q3 last year. Year-to-date, SG&A was 23.15% of sales, which leveraged 37 basis points versus last year.
Depreciation for the quarter was $375 million, which was 2.74% of sales and leveraged 14 basis points compared to last year's third quarter as a result of sales growth. In Q3, earnings before interest and taxes or EBIT margin increased 81 basis points to 7.95% of sales. For the first three quarters of 2014, EBIT margin was 9.1% of sales, which was 67 basis points higher than the same period last year. For the quarter, interest expense was $134 million and deleveraged one basis point to last year as a percentage of sales. The effective tax rate for the quarter was 38.6%, which was higher than last year's 37.6%. The higher rate, which was consistent with our expectations, was the result of tax programs that expired at the end of last year. Net earnings were $585 million for the quarter, an increase of 17.3% over Q3 2013.
Earnings per share of $0.59 for the quarter were up 25.5% to last year. This was roughly $0.05 higher than our expectations, driven by both higher sales and better expense leverage. For the first nine months of 2014, earnings per share of $2.24 represented a 21.7% increase over the same period last year. To a few items on the balance sheet, starting with assets. Our cash and cash equivalents balance at the end of the quarter was just under $1.6 billion. Our inventory balance of $9.8 billion increased to $169 million or 1.8% versus Q3 last year. Inventory turnover was up two basis points over last year at 3.73 times. Asset turnover increased nine basis points to 1.65. Moving on to the liabilities section of the balance sheet.
Accounts payable of $6.5 billion represented 11.8% increase over Q3 last year, caused by the timing of purchases year-over-year. In the third quarter, we issued $1.25 billion of unsecured bonds. The bonds consisted of five, 10, and 30 year issuances with a weighted average interest rate of 2.55%. At the end of the third quarter, lease-adjusted debt to EBITDAR was 2.21 times. Return on invested capital increased to 176 basis points for the quarter to 13.02%. Now looking at the statement of cash flows. Cash flow from operations was almost $4.7 billion, an increase of $825 million over last year, largely due to working capital as well as growth in net earnings. Capital expenditures were $587 million, down nearly 4% from last year. Year-to-date free cash flow of $4.1 billion was 26% higher than last year. In the quarter, we repurchased approximately 17 million shares for $900 million.
In the quarter, we received 2.3 million shares as part of the final settlement associated with the accelerated share repurchase program executed in Q2. We have approximately $3.4 billion remaining on our share repurchase authorization. Looking ahead, let me share our business outlook. We have combined our year-to-date performance with our previous assumptions for the fourth quarter. We now expect total sales increase of 4.5%-5%, driven by comp sales increase of 3.5%-4% and the opening of six home improvement stores and four Orchard locations. We are anticipating an EBIT margin increase of 70-75 basis points and expect that the improvement will come from both gross margin expansion and expense leverage. The effective tax rate is expected to be 37.2% for the year. We expect earnings per share of approximately $2.68 for the year, which represents an increase of 25.2% over 2013.
We are forecasting cash flows from operations to be approximately $4.2 billion. Our capital forecast for 2014 is approximately $1 billion. This will result in an estimated free cash flow of $3.2 billion for 2014. Our capital allocation priorities are to first invest in the business where we believe we can add value. Second, pay dividends. We are currently targeting a 35% payout ratio. Lastly, to repurchase shares. Our CapEx forecast for 2014 is less than originally planned. As a result, we are increasing our share repurchase assumption by $300 million to $3.7 billion for the year. Regina, we are now ready for questions.
To ask a question, press *1 on your telephone keypad. To withdraw your question, press the # key. In order to allow questions from as many individuals as possible, please limit yourself to one question and one follow-up. Our first question will come from the line of Daniel Binder with Jefferies & Company. Please go ahead.
Hi. Good morning.
Morning, Dan.
My question was related to two things. First was on ticket. Was there any significant inflation, or was it primarily just in any of the categories, like lumber, or was it primarily just big ticket doing better that drove the ticket growth?
Dan, it was primarily big ticket categories doing better. In the quarter, as Mike talked about, strength in OPE. We had good performance in appliances, flooring, and door. As it relates to inflation, deflation, we did see inflation in lumber, but that was largely offset by deflation in OSB boards and copper. Essentially no net inflation impact on the quarter.
You noted targeted promotions for a little bit of the weakness in gross margin. Is there a plan to continue that? What categories do you expect that to be in?
Morning. Yeah, we think the impact of promotions in the fourth quarter will be pretty much the same as it was in the third quarter. Largely focused around appliances.
Yeah. The target promotions were largely matching competitor offers. Nothing initiated by Lowe’s in the quarter. We do expect a similar promotional cadence Q4 relative to Q3. In fact, probably less than Q3 as a result of the industry largely going to full promotions for the month of November, primarily in appliances. Roughly 25 basis point impact in Q3, probably a 15 basis point impact in Q4. Less drag in Q4.
Q3 was appliances as well?
Appliances and big tickets.
Okay. Great. Thank you.
Thank you, Dan.
Your next question will come from the line of Michael Lasser with UBS. Please go ahead.
Good morning. Thanks a lot for taking my question. The spread between your comp and The Home Depot's U.S. comp narrowed to its lowest level in 4 years. It’s obvious to question about whether you think you benefited from the breach at The Home Depot. If you look at the stores that are in close proximity to The Home Depot stores, did those stores comp better than the others? If they did, you obviously deserve credit for capitalizing on some of the disruption.
Mike, this is Robert. I think as we look across the business, we really attribute our strong performance to the internal initiatives that we’ve been working on, combined with the strengthening macro backdrop. As I talked about in my comments, the FHFA numbers continue to improve, which means that you’re seeing improvement in home values in those small midsize markets, which I think, as I said, lines up well with our footprint. We’re focused on our strategic priorities. I think if you look at it to your direct question, probably 90-plus% of our stores are in close proximity to the competition. We wouldn’t have seen anything noticeable by trying to carve that out.
Okay. Given the cadence of when all that happened, it was hard to discern as well?
Correct.
Okay. My other question is on payroll expenses leveraging 50 basis points. That’s a good result. Do you think that you can maintain that type of performance moving forward, or was there something unique in this quarter that won’t let it continue?
Michael, we've made investment in weekday teams in 2013, really worked to optimize those beginning second half of 2013 into 2015. If you look at last year, we actually had some modest payroll deleverage, Q3 2013, which drove some outsized leverage Q3 this year. We've got some good tools in place that allow us to continue to optimize payroll. We do expect further leverage into Q4 and into 2015, probably not to the same degree we saw in the third quarter.
Bob, just to follow up on that, are you seeing a benefit to your conversion as a result, or was the traffic really driven by draw?
We have seen improvement in conversion rates. It's really everything we've been doing for DIYs and pros as relates to the payroll investment I noted, the inventory investment last year, the line review process that we went through with value improvement to really get rooted in the products that the customer cares about. We saw roughly a 100 basis point improvement in conversion rate in the third quarter.
Okay. That's very helpful, good luck with the holiday.
Thanks, Mike.
Thanks, Mike.
Your next question will come from the line of David Strasser with Janney Capital Markets. Please go ahead.
Thank you very much. Congratulations on a great quarter. When you look at your business versus 2005 during the last peak period of time, how different do you see the store? I guess what I’m trying to look at is when you think about sales on a per square foot basis, how dramatic have newer products been to the overall mix? If you were just looking at it just from a mix to mix standpoint, how much more opportunity do you think there would be in driving those sales on a like-for-like basis?
David, I’ll start. First of all, when we think about comparing the business all the way back to 2005, certainly it’s a dramatically different environment today. One from the overall macro environment and how strong housing was back then and what it was driving. Two, this whole omni-channel world that we’re in today. Our real focus is we’ve got a great footprint of stores out there that is the nucleus of where we’re going with our strategy. We’re building on that with obviously improving our online capabilities through our contact center for those that want to talk directly with an agent or through in the home where we’ve got project specialists, exteriors in all markets, and we’re rolling out our PSI program, which is capitalizing on recovering housing market.
I think all of those things set us up somewhat different from where we were back in 2005. One of the other things that we’ll talk about, as Mike alluded to in his comments, is we also think that brands are important, particularly with our pro initiative. That is a focal point the team’s been working on to ensure that we have the right brands we need in the store to resonate with the pro customer. I think that’ll also help us improve in those metrics as well.
Okay. When you just look at, I guess just from a dot com standpoint, you’ve talked about this a bunch, but from an incremental standpoint, how much do you think that can ultimately help productivity in the store? I know it’s a big question. Just a little bit bigger picture.
I think it will be significant because in today’s world, with where we’re at from a technology and a customer expectation standpoint, I don’t think you’re going to be relevant if you don’t have a website that, one, is functional, feasible from the consumer’s standpoint, but also well-connected to your other channels of business. That’s why we’re after an omni. It’s not just multiple channel, it’s an omni channel where these work together because that really gets back to being able to be there and meet the customer whenever and wherever they choose to engage in a simple and seamless manner. That’s what we believe our customers are looking for.
Even though it may be a small percentage that it actually transacts online, that it's heavily induced by people starting their research online, like 80% or 90% of people that start on mobile, there's only about 10% of them conclude a transaction there. They are looking for what's available in store when they're visiting you.
If you think about our holiday decor experience, we talked to the fact that it starts online with Pinterest, it starts online on lowes.com, it starts online with Vine to drive inspiration, and then they come into the store. Likewise, we saw the same thing happen over the spring with our outdoor spring experience.
Yeah, I think that the holiday looks fantastic. Anyway, thank you very much. It just looks really good in store right now.
Thanks, Dan.
Your next question will come from the line of Scot Ciccarelli with RBC Capital Markets. Please go ahead.
Hey, guys. I know you highlighted strength in the pro, and I think Mike mentioned some specific initiatives you guys are doing to drive market share. Your friends in Atlanta are also focused on this pretty important customer base and also doing well. I guess my question is, do you think there's a lot less competition out there to serve the pros than what we had maybe a couple of years ago due to the downturn, which I'm assuming took out a lot of competitive capacity, number one? Number two, how should we think about your opportunity in this segment going forward?
I don't know that I'd say there's less competition. There's been some consolidation of some of the small local and regional players, but I don't know that I would think about the competitive set any different. The example I used was Henry Cody in my address earlier. Where we have the right brands, where we have the right inventory, where we have the right localization, we see growth. We're excited about it, and we'll talk more about some of our pro initiatives at the upcoming AIC meeting.
Scot, this is Robert. When you think, it kind of dovetails onto our last question, when you think about competition. There may have been consolidation, there may be fewer just dedicated pro lumber and building material yards than there were before the downturn, but also think about technology and how that's changed with, for example, online and the availability now of being able to interact with the DIY or pro customer online. That's why we're focused on launching our lowesforpros.com, because it may be different, but it's still a competitive market.
As you guys can invest more in technology and have those systems and capabilities, in theory, you should be able to continue to gain market share with that customer base.
Correct. That's why obviously we continue to have plans to invest funds in those areas.
Got it. Thanks, guys.
Your next question will come from the line of Laura Champine with Canaccord. Please go ahead.
Good morning. Robert, could you just comment on how much Orchard Supply added to your comp this quarter?
I'd say added nothing to comps for the quarter. If you think about the size of the business, technically it was only in the comp base for two months. Really, with or without Orchard, the comp number would not have changed, Laura.
Thanks. Could you also comment on what drove the appliance business? We're particularly surprised by the strength that you saw there in the quarter.
We spoke to being certainly promotional at the same level as our competitive set in the appliance business a few minutes ago. I like our footprint on appliances. I like the amount of space that we dedicated to the floor for appliances. We're proud of the fact that we have large stores, so we can dedicate space to appliances and not have to detract space from other important categories like cabinets that helps the consumer pull the entire project together. I like our brands. I also like the fact that as we think about building out better experiences, we own that appliance experience with a customer all the way through to the last few feet. We deliver the appliances, we facilitate the installation. We really do own that experience. We feel good about our position.
We think that the way we're merchandising appliances, our partnerships with key brands like Bosch, Whirlpool, GE, Electrolux allows us to offer everything the consumers need, and it's an area that we're pretty well focused on.
Got it. Thank you.
Thanks, Laura.
Your next question will come from the line of Seth Basham with Wedbush Securities. Please go ahead.
Good morning, congratulations on a good quarter.
Thanks, Seth.
My first question is around some of these big-ticket category drivers for the quarter. Would you care to quantify how much appliances and OPE added to the comp?
Don't have exact quantification. As Mike spoke of, OPE was in the mid-teens from a comp perspective. Appliances was above the company average. Both were certainly drivers. Seth, if you look at tickets above $500, comp was up a little higher than 9%. Certainly big ticket was a driver of the comp in the quarter led by the categories we spoke about previously.
Got it. As you roll into Q4 with continued promotional environment in appliances, do you expect to see the same level of comp contribution from that category?
I think, as we spoke about earlier, last year was kind of Black November from appliance perspective. While the level of intensity will be more consistent, the impact will be muted because we're comping against efforts for last year. I think we will see more balanced performance. We do see continued strength in OPE, but probably not to the degree we saw in Q3. I would expect a little bit more balanced performance across categories in Q4.
Got it. Thank you very much.
Thank you, Seth.
The next question will come from the line of Budd Bugatch with Raymond James. Please go ahead.
Good morning. This is David on for Budd. Congratulations on a good quarter. I had a question just about inventory levels and supply chains. You had your competitors mention being in a good in-stock position going into the holidays, definitely seeing some troubles, I guess you could say, in their supply chain, notably some congestion at the ports and also issues with driver shortages. Can you comment on if you're seeing any of that?
This is Robert. I'll start, Dave. When we think about Black Friday, when we think about the holiday season, we think we're in great shape with the inventory already landed and either in our stores or in our distribution network. Certainly, with what's going on on the ports on the West Coast, keeping a close eye on it. Our team is heavily focused on that and working to develop contingency plans based on how that situation unfolds going forward. We've been through this before it may cost more to get the freight in, but we'll do what we need to as we think about looking ahead to spring. Keep in mind, when you think about our network of distribution centers, our distribution centers aren't just for cross-docking. They also hold inventory.
That gives us great flexibility as product is landed to go ahead and bring it in, either in our import centers or in our distribution centers to have it available then to push out to our stores. We're in great shape as we head into Black Friday into the holiday season this year. Yeah, there has been a little bit of pressure when you think about higher costs from driver availability and stuff like that. Fortunately, with lower fuel prices that's helped to offset some of that cost to what we've experienced to date.
Okay, great. Thanks for that color. One more question just on the modeling going forward. In terms of the 70 to 75 basis points of operating margin expansion you see, can you give us an idea of what the contribution split would be roughly between gross margin and SG&A? Is it going to be similar to what we saw this quarter or a little bit more balanced?
I assume you're talking about Q4?
Yes, Q4. Yes.
For the year, we expect the gross margin to be roughly consistent with where we are to date. The three quarters have performed well to the last year. The lion's share of the expansion is going to come from expense leverage. As you've heard us talk about, we really focused on driving productivity and flow through, good expense productivity. We'll see even more of that in the fourth quarter, driving productivity. We talked about payroll. We'll leverage bonus expense in the quarter. We also had some impairments in Q4 last year we don't expect to recur this year, so we'll have some healthy expense leverage in the fourth quarter.
Great. Thanks a lot, guys.
Thank you, David.
Your next question will come from the line of Mike Baker with Deutsche Bank. Please go ahead.
Hi. Thanks. Just focusing on that margin. In the past, you've talked about a rule of thumb of 20 basis points of margin expansion for every 1% comp above 1%. Your guidance this year is ahead of that, closer to 25 basis points-30 basis points. My question is, how do we think about that going forward? Is your efficiency and productivity such now that that rule of thumb should go higher?
Yes, we believe so. We think back to where we've been over the past number of years. The focus initially was on stabilizing the revenue, then shifting gears towards productivity and profitability. We're in that phase of focus on productivity and profitability. We expect 2015 hopefully looks a lot like 2014. We're in the throes of developing our plans for 2015, like 2014. We hope to grow comps with flattish payroll hours and flat inventory dollars. We'll give you more details on 2015 on the Q4 call in February.
I guess the follow-up question is, with that higher rule of thumb and thinking it might occur next year, does that give you visibility into that 9.7% operating margin for 2015 that you guys talked about in December 2012?
Certainly. That's been part of the plan all along. That's why we've not wavered from the 9.7%, is we need to grow both top line and productivity. We are getting better flow through now as you suggested, Mike, in the 25 to 30 basis point range. We'd like to see if that's hopefully towards the high end of that range in 2015, but again, more to come.
Great. Thank you. Very helpful.
Yeah. Thank you, Mike.
Your next question will come from the line of Peter Benedict with Robert W. Baird. Please go ahead.
Hey, guys. My question is on the pro versus DIY when we think about it from a margin perspective. Can you talk through the average margin profile of a pro basket versus the average DIY basket? How materially does it differ?
Pierce, this is Robert. I'll start and let the others add on. When you think about it, as we talk about the pro and the pros that generally we target that shop our stores, they're generally buying across the store. You generally are not seeing a significant difference in the margin rate on the basket of what they're buying versus what our typical DIY customer would be purchasing.
How about the average spend per year? Have you guys benchmarked that in terms of what you think your pros are spending on average?
The average pro spend is probably in the $2,000 range. As Robert indicated, they're buying across the store. There's a healthy margin mix. We feel good about the game plan to serve the pros.
Okay, great. Thanks, guys.
Thanks, Pierce.
Thanks, Pierce.
Your next question will come from the line of Brian Nagel with Oppenheimer. Please go ahead.
Hi, good morning.
Good morning.
Congratulations on a great quarter.
Thanks.
A couple questions. One long, one short. For the long one, a lot of talk from you and others about this pretty significant market share shift we're seeing in the appliance business. You're clearly benefiting from it. As you look at your customer data, you're getting that maybe potentially that new customer now buying an appliance at Lowe's, is that someone that's new to Lowe's store, or is it an existing customer now you're expanding their share of wallet, so to say? How sticky has that customer been? If there's any way to determine that.
Well, I think I'll start, Brian, I'll maybe get Mike or others to jump in. Certainly, as we continue to improve the way we go to market, even improving things like website functionality and the website search and those type of things, we're making sure that when the customer is in the market to buy an appliance, we're top in the consideration set. Still, a majority of the appliances, or a significant amount of the appliances that we sell are still replacement of appliances in a distressed situation. Being there at the right time. You also know that as the remodeling market is coming back, consumers are going to put in a new kitchen. We also want to put it in the kitchen, we want to sell them the appliances as well.
If you think about a lot of our targeted efforts, whether that's our PSI program or those type of things that are really working in a more effective way with the consumer in improving their home. I think all of that helps us by having the right products, the right brands, making sure that we're there when the customer needs us and on an omni-channel basis, I think helps. That we've got all the key brands out there, as Mike indicated earlier in his comments. I think it just positions us well, given that the majority of the customers that come in our store every day are homeowners when it is time for an appliance. They're familiar with the brand. They know Lowe's, and it sets us up well to continue to gain share in the appliance industry, so.
Yeah, I'd add a couple things to that. If you think about our ability to help the consumer pull together that project by deploying our project specialists to their home, that's going to help us expand our relevance with customers that we have and gain some new customers. In addition to that, if you think about the way we're building out better experiences, starting online, going into the store, we think that also helps us both make the customers that we have more sticky as well as start to lean into some new customers. We don't look at it as either/or. We look at it as you got to go after both.
Got it. Okay, thanks for all the color there. The second shorter question, and I don't think you've mentioned this yet, but any comment on sales trends thus far in Q4, recognizing we're early in a back-end weighted period?
Yeah. Brian, we're off to a great start. In fact, we're very impressed with our results thus far, but it's still very early in the quarter, and there is weather risk in January. At this point, we're comfortable with the guidance we provided thus far.
Cool. Thank you. Congrats.
Thank you, Brian.
Thanks, Brian.
Your next question will come from the line of Eric Bosshard with Cleveland Research. Please go ahead.
Two questions. First of all, in terms of market share, your performance this quarter looks improved from what you've posted recently. I know you've talked a bit about appliances and outdoor power, but from a bigger picture perspective, Mike or Robert, what do you think is changing, and is that sustainable in terms of your market share performance?
Eric, I'll start, and then I'll get Mike to jump in. Yeah, I think it's a lot of the heavy lifting we've been doing over the past few years, past few quarters, whether it's the line review process, whether it's the incremental inventory that we put in the stores, whether it's the customer experience work that we've been doing to bring better experiences. It's improvements that Mike and his team have been working on for the website to make a better experience, better connected. Then things like was talked about earlier on the call with the weekday teams. We launched those a couple years ago as those people could gain, get more experience as we get their hours adjusted in the right part of the store at the right time to meet the consumer's needs.
Yeah, it feels good, particularly in, as we talked about with the environment and home prices improving on a broader scale, sets up well for our footprint and then some of the work that the team is doing to really focus more on the opportunity with that pro customer. Yeah, it does feel like we've got opportunity to continue to gain market share and to be able to deliver better performance.
Yeah. Good morning, Eric. I'd agree. It's difficult to measure share. You have to use a lot of different data to get to a perspective. We also believe that we're gaining share. I'd add a couple things. I think our associates are doing a phenomenal job. They're energized. They're engaged. They're meeting the needs of our customers. We're so appreciative of what they do. Our outdoor selling teams, our pro teams, are doing a phenomenal job. The project specialists continue to do a fantastic job. To Robert's point, our initiatives are really starting to gain good traction. We talked about sales and operations planning, where we start to plan out the upcoming selling season 6 months to 1 year in advance. That helps make sure that we have the inventory we need, so we can meet the customer's needs.
We talked about our better utilization of our larger stores, which we believe to be a distinct competitive advantage, where we can show products like our innovations on our innovation end caps. I don't want to miss our vendor partnerships. So, so critical. We've got great vendor partnerships that are bringing us innovations in first to markets and working with us to make sure that we have the right brand portfolio to meet both the needs of the pro as well as the need of the do-it-yourself customers. A lot of things going well. I know that in your shops, Eric, you've heard lots of things from our merchandising team and how engaged they are, and they're doing a phenomenal job as well. Just a lot of things going well, and we're proud of the teams.
Great. That's helpful. Secondly, in terms of the margin progression, Bob, your commentary and sticking with the 9.7 next year, I know there was a period of time where it felt like a larger gross margin emphasis in the company. It feels like there's now perhaps recognizing an opportunity to better lever SG&A. Just wondering if you can give us a little bit more color on your thought of the slope of margin improvement from here, and other than sales progress, is there something incremental you're accomplishing that allows you to lever or improve margin at a better rate than you've done in the past?
Eric, what I'd say is that we guide to EBIT because there's pushes and pulls with margin and expenses. We want to manage the business with flexibility to respond to competitive actions. We want to have the flexibility to manage our initiatives and put our initiatives into place. I'm not sure if the mindset's necessarily different, Eric. We certainly expect to have both gross margin improvement and SG&A leverage. It just so happens we're at the point where we're identifying a lot of productivity opportunities that happen to be expense related at this juncture. As the merchant teams go through round 2 and round 3 of value improvement, there's still opportunities to bring value to the consumer. As Mike discussed, partnering with our vendors, we think there's additional gross margin opportunities from that going forward.
It just so happens at this juncture, we're seeing a little bit more opportunity from expense.
Great. Thank you.
Thanks, Eric.
Your next question will come from the line of Matthew Fassler with Goldman Sachs. Please go ahead.
Thanks a lot. I've got a couple of follow-ups. Can you talk to us, if you look through some of the ticket metrics for this quarter, which have some one-offs like OPE. What is the ticket cadence and sort of the customer traffic in some of the bigger ticket areas telling you about where the customer is in the home investment cycle relative to the past couple of years? Are you seeing a deepening of interest in some of the bigger ticket project-oriented areas, or are we still talking about more of the repair and maintenance kind of categories driving the business today?
Well, I'll start, and then I'll let the others jump in. As I said in my comments, as we see the consumer getting engaged in home and home improvement and their thoughts around the home, their confidence in both local and national housing market and the value of their homes improving. We are seeing them continue to get engaged in taking on discretionary projects. Today, most of those are still in the smaller projects, which we label as $500 or less, but we did see an uptick versus the same quarter last year in a willingness to take on larger projects, which we think bodes well going forward as we continue to see home values continue to improve and consumer finances continue to improve.
Okay, the second level of my question, just following up, Bob, you addressed a moment ago that the merchants would go back and take a look at other opportunities for value improvement. What do you think is left, either quantifiably or areas of the business that you feel you maybe didn't optimize in the first round as you look at gross margin opportunity?
Go ahead. This is Mike Jones. First, from a value improvement perspective, we view this as the way we work. It's not something that will be done. We're going to continue to use that process to continue to work with our vendor partners to create more value for our customers. We've gone through round 2 this year and made great progress. Candidly, when we finish round 2, there'll be a round 3, followed by round 4, followed by round 5. As we continue to look at our business, we continue to find opportunities where it's an opportunity for us to partner with our vendor partners to take out more costs, quite frankly, both from our side and from their side, and deliver more value to our customers. To me, this is not a one and done. We'll be doing this in perpetuity.
Matt, I would add, just think about 400 line reviews, and the average line review had four clusters. There's no way we got 1,600 clusters right. There's opportunity to continue to go back and refine the approach, dig into the demographics, the customer data, the performance to continue to refine the steps.
Thank you so much.
Regina, we've got time for one more question.
Our final question will come from the line of Aram Rubinson with Wolfe Research. Please go ahead.
I had a feeling it was going to be me Bob, I got your reference. I'm glad you're impressed with the start to November. Just so you know. One kind of softer question and then one more specific. You seem like you're on a good glide path where your comps are now equal to the competition, maybe even better in October. Your DSIs are down, your DSPs are up. Your business seems to be stable. Can you just tell us about the feeling of the organization? I know that wins sometimes beget more wins, I'm just kind of curious whether or not you're at that stage of maybe building momentum internally.
Aram, this is Robert. Yeah, you nailed it. Momentum's a powerful thing. I think we see a lot of bounce in people's steps. There's a lot of initiatives that we've been working on. There's been a lot of heavy lifting over the past couple of years all the way across the organization, both in the stores and the corporate offices. We repositioned the company to more of an omni-channel environment, made some great strides and great improvements that's starting to come together. You are seeing a lot of bounce in people's steps and a lot of wanting to deliver even better performance in the future.
Great. Well, we will be sure to wear our sneakers to the Analyst Day. My other question is just on the pro. Tool rental is something that we've heard is near and dear or at least of interest to pro customers, and I think you guys don't really have that in terribly many stores. Can you talk about whether or not that's something you're working on or if you just don't see the merit in it? Thank you.
Aram, yeah, we've got it in a handful of locations. It's something that we've continued to put on the list to evaluate. Quite frankly, with all the other things that we had to get done over the past couple of years, we had other things that we thought were higher priority. It's something that's on the list. We'll continue to evaluate. It's something we may look at doing in a better way in the future. As of today, we've not made any decisions regarding tool rental.
Okay. I look forward to seeing you in a couple of weeks. Thanks.
All right. You too, Aram. Thanks. Thanks again as always. Thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our fourth quarter 2014 results on Wednesday, February 25th. Have a great day.
Ladies and gentlemen, this does conclude today's conference call. Thank you all for joining, and you may now disconnect.